Study Warns Companies Against Being Too Quick to
Freeze DB Plans

June 5, 2006 (PLANSPONSOR.com) - Since October 2003,
20 companies have frozen their DB plans, but in an analysis
issued this month, Merrill Lynch advised companies to wait
and see what the pension landscape will look like in the
future, rather than simply following the lead of other
companies.

According to the report, freezing DB plans is not a
new trend and does not necessarily mean underfunded plans
forced companies to freeze their pension assets.
According to the report, 168,725 companies terminated
their DB plans from 1975 to 2004, which, Merrill Lynch
contends, marks the “extended decline” of the DB plan.
About 98% of these companies, 165,256, had enough assets
to pay their contributions.

The report defined the three types of freezes: hard
plan freezes, in which every participant stops receiving
benefits in the DB plan on an effective date; partial
plan freezes, in which a segment of the active
participants stop accruing benefits; and soft plan
freezes, similar to hard freezes in that service stops
receiving benefits on a certain date but employers still
consider future pay increases when they calculate
participants’ projected pensions.

In hard plan freezes, companies usually increase
contributions to another benefit plan after the freeze,
according to the report. In partial plan freezes,
participants may have a choice whether to continue
accruing benefits in their DB plans or begin accruing
benefits in another plan, such as 401(k) plans.

According to the report, companies in the past
froze their DB plans for reasons such as the high
interest rates of the 1980s and the introduction of
pension accounting standards. Today, though there are low
interest rates, there are also high premiums that are
charged for close-out annuities.

The report included
a Mercer Human Resource Consulting survey of plan sponsors,
who said the top two reasons that they decided to change or
freeze their plans was to ensure long-term cost savings and
reduce cost volatility.

According to the report, the government could pass
permanent Employee Retirement Income Security Act (ERISA)
funding legislation by the end of July. Merrill predicted
that the government will extend the time table for
airlines to pay back their plan defectives to a period of
more than 20 years, rather than seven years.

Northwest Airlines asked the government in May to
help fund its three underfunded pension plans, which have
a $3.7 billion shortfall altogether (See
Pension Bill Likely to Save Northwest Pension Plans
). If its proposal is accepted, the airline will have two
decades to pay contributions to its plans. If Northwest’s
proposal is declined, executives say the airline will be
forced to terminate the pension plans.

In January, Northwest’s pilots union agreed to take a
29.9% pay cut as well as for the company to freeze its DB
plan and switch to a DC plan (See
Northwest Pilots OK DB Plan Freeze
). The agreement is expected to save the airline $358
million per year. General Motors announced in February that
it would freeze its DB plan in favor of a retirement
savings program and a retiree health coverage cap
(See
GM DB to DC Pension Move among Belt-Tightening Steps).

But if age discrimination issues facing cash
balance plans are resolved in the House and Senate, the
Merrill report said, airlines may not have to freeze or
terminate their plans because new types of DB plans could
reverse the trend.

The theory behind freezing a plan is that it will
allow employers to keep cash on their balance sheets
rather than locked in pension plans; however, it does not
always make sense for a company to freeze its DB plan,
(See
The Bottom Line: Back to the Drawing Board
).